1) Assuming you want the bank to approve the short sale, in a manner that you don’t have to pay any remaining balance on the loan, you’ll need to convince the bank that this is a good deal—probably the best it can expect to receive (the same as you would for any short sale). The natural assumption will be that you are giving your relative a break and/or he or she is kicking something back to you under the table, so it will be more difficult to get the bank to approve a short sale to a relative than it would an ordinary short sale—and those are hard enough to get approved as it is.
2) If the bank suspects collusion—such as that the relative is kicking back some money to you under the table—then they may accuse you of fraud and possibly either sue you for damages and/or refer the matter to law enforcement.
Therefore, what you will need to do is to prove to the bank that this is on the up and up; that your relative is getting the same terms that a stranger would get in an arm's length transaction. Transparency and documentation should be your watchwords. For example, you will want to document comparable sales in your area even more carefully than you would for a “regular” short sale, to show that the amount being offered you is market rate for your home.
You should disclose up front that the relative is a relative—if it comes out later, the suspicion will be that you tried to hide the fact for nefarious purposes.
You should also document all your financials and your situation very thoroughly, as you would for any short sale. You have to show real hardship and need before a bank will consider this.
Also, be aware that certain behavior will be viewed with suspicion. If any otherwise unaccounted for payments or assets show up when your financial situation is reviewed, for example, the bank may think these are proceeds from additional consideration for the sale.
In short, pretend you’re running for President and assume that any hint of impropriety will be pounced on—then make sure there is no hint at all.